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Do States Tax Wireless Services Inefficiently? Evidence on the Price Elasticity of Demand

AbstractJ. Gregory Sidak

The taxation of goods and services by a state is considered efficient when consumer welfare is maximized subject to the condition that the local government raises a specified amount of revenues. According to the Ramsey principle of optimal taxation of commodities, an efficient commodity tax induces little change in consumer behavior and does not fall on a good that is relatively important in the budgets of the poor. Therefore, the optimal commodity tax is one that consumers cannot easily avoid, a characteristic that leads to the conclusion that a particular tax’s efficiency will be greater the more insensitive is consumer demand to the price of that good.

States are increasingly relying on the taxation of wireless services as a source of revenue. For example, the average wireless consumer in New York pays a 16 percent tax on his wireless bill, which is nearly double that of the average business tax in New York. In fact, the average state tax rate on wireless services exceeds the average state tax on general business services by 2.34 percentage points. States have not, however, analyzed consumer demand for wireless services to determine whether it is efficient to tax wireless services with such intensity.

In this paper, we estimate the own-price elasticity of demand for wireless service using a survey dataset of wireless consumption. Using data on wireless consumption between 1999 and 2001, we find that the own-price elasticity of demand for wireless services is between -1.12 and -1.29. With these elasticity estimates, we find that reducing the taxation of wireless services by one dollar would improve economic welfare by between $1.23 and $1.95. This empirical finding calls into question the wisdom of the high taxes that many states impose on wireless services.